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CESifo, a Munich-based, globe-spanning economic research and policy advice institution
Venice Summer Institute 2014
Venice Summer Institute
July 2014
REFORMING THE PUBLIC SECTOR
Organiser: Apostolis Philippopoulos
Workshop to be held on 25 – 26 July 2014 on the island of San Servolo in the Bay of Venice, Italy
PUBLIC DEBT, FISCAL CONSOLIDATION AND THE
EFFECT ON EMPLOYMENT
Verónica Escudero and Elva López Mourelo
CESifo GmbH • Poschingerstr. 5 • 81679 Munich, Germany
Tel.: +49 (0) 89 92 24 - 1410 • Fax: +49 (0) 89 92 24 - 1409
E-Mail: [email protected] • www.cesifo.org/venice
Public debt, fiscal consolidation and the effect on
employment*
VERÓNICA ESCUDERO Δ
Research Department, INTERNATIONAL LABOUR ORGANIZATION,
(Geneva, Switzerland)
e-mail: [email protected]
ELVA LÓPEZ MOURELO
Research Department, INTERNATIONAL LABOUR ORGANIZATION,
(Geneva, Switzerland)
e-mail: [email protected]
ABSTRACT
This paper assesses the magnitude and nature of fiscal consolidation policies and their impact on
employment. In particular, in an attempt to address fiscal imbalances in the near term, countries have
been faced with the delicate challenge of doing so without damaging recovery prospects and thus,
counter to their original aim, worsening further public finances. In this regard, the paper reviews
recent austerity measures adopted by governments and discusses how prolonging fiscal consolidation
measures in their current form could be counterproductive for guaranteeing debt sustainability in the
medium term. In particular, the article sheds light on how poorly designed fiscal cuts – directly or
indirectly affecting labour, have dampened job prospects and income, weakening in turn aggregate
demand and aggravating fiscal balances further. The paper shows how fiscal and employment goals
can be achieved together. Indeed, the latter is central to the former. More specifically, a fiscallyneutral change in the expenditure and revenue composition of fiscal consolidation would boost job
creation. In this sense, the paper shows that it is imperative to find the right policy mix and
recommends countries to be mindful of the nature and pace of consolidation.
Keywords: public debt; fiscal policy; consolidation; employment growth; public investment; social
benefits
JEL Codes: H62; H63; E6; E24.
*
The authors would like to thank Steven Tobin for valuable contributions and comments in final and preliminary
versions of this paper. Excellent feedback on the first version of this paper was provided by Miguel Ángel Malo
(University of Salamanca) and Nikolai Staehler (Deutsche Bundesbank). Research assistance by Cecilia Heuser in the
latest version of this paper is gratefully acknowledged. The results of the empirical analysis developed in this article have
been summarized in Chapter 3 of World of Work Report 2012 prepared by the authors at the Research Department of the
ILO (former International Institute for Labour Studies, IILS) in Geneva (See ILO, 2012). The views expressed herein are
those of the authors and do not necessarily reflect the views of the International Labour Organization.
Δ
Corresponding author. Research Department, International Labour Organization, 4, route des Morillons, CH-1211
Geneva 22, Switzerland. E-mail: [email protected]. Tel. +41 22 799 6913. Fax: +41 22 799 8542.
ͳǤ –”‘†—…–‹‘
In response to the financial and economic crisis that erupted in 2007/08, governments mobilized
sizable fiscal support to safeguard the financial sector and put forth stimulus measures in an effort to
stimulate aggregate demand. The increase in government spending at the time was seen as a
necessary, but temporary measure, to support the economy until private sector demand recovered.
Yet, the boost to growth was short-lived as private sector business activity and investment in the real
economy continued to falter. Meanwhile, government revenues have dramatically deteriorated
principally through shortfalls in tax revenues.ϭ As a result, public debt ratios in the majority of
countries analysed have increased significantly and are set to continue their upward trend over the
coming years.Ϯ In the face of this situation, most advanced countries have adopted fiscal
consolidation measures with detrimental consequences for employment.
Against this background, the key question that remains is how to stimulate economic activity against
the backdrop of pressures on governments to rein in expenses and weak private sector demand. With
this in mind, this paper assesses the magnitude and nature of the fiscal consolidation challenge.
While fiscal imbalances need to be addressed in the near term, the challenge is to do so without
damaging further recovery prospects and while safeguarding public finances. In particular, the
analysis is centred on the employment and social implications of poorly-designed fiscal cuts. The
paper starts by providing a literature review on the effects of fiscal policy and budget composition on
macroeconomic aggregates (Section 2). Section 3 examines the evolution of fiscal balances and the
recent build-up of public debt and looks at the recent government efforts to consolidate public
finances. This section also analyses how prolonging fiscal consolidation measures could be
counterproductive for guaranteeing debt sustainability. Moreover, section 4 assesses quantitatively
the impacts of a change in the expenditure and revenue composition of fiscal consolidation on
employment creation to shed light on how fiscal and employment goals can be achieved together.
Finally, section 5 presents the conclusions of the analysis and elaborates on the policy implications
of the main findings.
ʹǤ ‹–‡”ƒ–—”‡”‡˜‹‡™
Since public deficits reached their peak in 2009, the vast majority of advanced economies have
adopted fiscal consolidation measures. There are various reasons to explain why healthy budgetary
balances and low public debt are necessary. Firstly, fiscal deficits reduce national savings and raise
interest rates. As a result, investment and net exports fall. This leads to a combination of a smaller
capital stock and greater foreign ownership of domestic assets. In the long run, fiscal deficits can
substantially reduce the economy’s capacity to produce goods and services, through changes in the
stock of capital. Secondly, budget deficits and high public debt ratios also affect the distribution of
income by leading to lower real wages and higher rates of profit. Thus, by reducing the capital stock,
1
See Chapter 3 of the World of Work 2010: From one crisis to the next (ILO, 2010) for an analysis of the different
channels through which the crisis affected fiscal balances.
2
See Cecchetti et al. (2010) and IMF (2012b).
1
fiscal deficits can in turn reduce the productivity of labour and raise the productivity of capital –
since the scarcity of capital makes the marginal unit of capital more valuable (Ball and Mankiw,
1995; Heylen and Everaert, 2000). Indeed, based on endogenous growth models, healthy public
accounts favour long-term economic growth and, consequently, job creation (Barro, 1990; Rebelo,
1991; Easterly and Rebelo, 1993).
An opposed theoretical framework exists, however, that advocates the systemic use of fiscal and
monetary policy to regulate aggregate demand both in the short- and in the long-run. These authors –
usually defined as post-Keynesians – share a common stand regarding the issue of fiscal
consolidation in the long-run. The guiding principle among these economists, which leads to a
divergence from the orthodox view, is the utmost importance of the effective demand principle,
according to which both output and employment are generally demand-constrained rather supplyconstrained (Davidson, 1999; Kalecki, 1990; Minsky, 1986). According to this school of thought, the
principle of effective demand should govern fiscal policy and, therefore, governments should run
deficits, surpluses or balanced budgets depending of what is necessary to fulfil the macroeconomic
requirements of stabilizing the economy and maintaining full employment (King, 2008). This is the
idea behind the Lerner’s concept of “functional finance” (Lerner, 1943) – as opposed to “sound
finance”. These economists, therefore, worry much less about state failure than about market failure.3
No consensus exists either on the short-term impact of fiscal consolidation on economic growth and
other macroeconomic variables. There are two clearly opposed theoretical frameworks regarding the
short-term effects of fiscal austerity. On the one hand, the Keynesian approach supports the view that
fiscal consolidation reduces economic activity due to a fall in aggregate demand. This fall can be
either directly caused by a reduction in public consumption or investment, or indirectly caused by the
fall in private consumption – brought about by higher taxes or lower transfers to households. In line
with this, the so-called accelerator mechanism (Samuelson, 1939) will imply that changes in
investment as response to the fall in output will amplify the effect of any change in private
consumption or government spending on aggregate demand (Hemming et al, 2002). On the other
hand, the substantial fiscal adjustments implemented in many EU countries during the 1990s were
based on the belief that fiscal consolidation had positive effects on demand even in the short-term.
This approach is referred to as the expansionary fiscal contractions hypothesis (Giavazzi and Pagano,
1990; Alesina and Perotti, 1995). It is based on a number of studies that found that fiscal
consolidation boosts private investment and consumption, due to falling real interest rates to an
extent that the contractionary Keynesian spending effects were reversed. A key factor in this
approach is the expected increase in investor confidence that fiscal consolidation may engender,
which would further decrease interest rates (Heylen and Everaert, 2000).
No agreement exists within the empirical evidence as to which of these two opposing effects is
stronger. Results are mixed across methodologies, data and countries (Kneller et al., 1999; Aarle and
3
Some economists of this stream of thought would go even further to suggest that since government spending crowds in
(not out) private investment, permanent deficits mean permanently higher business profits and higher levels of
investment expenditure (Kalecki, 1971). Hyman Minsky supports this argument adding that debt accumulation (as a sum
of past deficits) renders private sector balance sheets more robust, reducing the danger of financial instability (Wray,
2009).
2
Garretsen, 2003). However, the vast majority of studies agree that the composition of fiscal
consolidation programmes plays a crucial role in determining whether fiscal contractions lead to
economic growth. Alesina and Perotti (1995) were among the first researchers to show that the
composition of fiscal consolidation matters in terms of its macroeconomic outcome. In particular,
they found that fiscal adjustments driven by cuts in transfers and on the wage component of
government consumption can foster growth, while adjustments that rely on labour-tax increases and
public investment cuts tend to be contractionary. Empirical evidence supporting this composition
hypothesis has also been provided by Giavazzi and Pagano (1996), Alesina and Ardagna (1998) and
Kneller et al. (1999).
In this context, this paper aims to assess whether fiscal consolidation based on a balanced policy mix
would be capable of meeting deficit targets all while affecting positively job creation. This is in line
with the so-called balanced budget multiplier theorem (widely accepted in Macroeconomics) that
asserts that it is possible to change aggregate demand – by an amount equal to the change in
spending – keeping a balanced budget. However, our empirical approach differs in some aspects
from what has been usually done in past analyses. First, while the impact of budget composition on
economic growth has been extensively assessed in previous studies, the econometric evaluation of its
effects on employment creation was absent from the analysis. This paper will fill this void and will
do so from the point of view of the current global crisis, which is another novelty of our study.
Indeed, the bulk of the research carried out has analysed the impact of fiscal consolidation on growth
during 1990s – given the priority attached to fiscal consolidation in many countries during that
decade – and only a handful of studies have focused on the current crisis. This is an important issue
to take into account since the literature points to the crucial role of the circumstances in which
consolidation takes place.
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Since the onset of the crisis in 2007, public debtϰ has increased rapidly in advanced economies,ϱ
driven by a deep recession and a double dip in terms of falling GDP in a number of countries.
4
Public debt in this paper is measured as the ratio of general government gross debt to GDP. Gross debt consists of “all
liabilities that require payment or payments of interest and/or principal by the debtor to the creditor at a date or dates in
the future. This includes debt liabilities in the form of special drawing rights (SDRs), currency and deposits, debt
securities, loans, insurance, pensions and standardized guarantee schemes, and other accounts payable.” (IMF, 2011b).
This definition of debt is consistent with the definition of debt in the Government Finance Statistics Manual (GFSM) and
the System of National Accounts 2008 (European Commission et al., 2009). Gross debt, rather than net debt or the net
present value of debt, has been preferred in this analysis for two main reasons: firstly, it is widely accepted that there are
less problems in the measurement of gross debt (the financial assets of general government are difficult to measure and
this difficulty may distort the official figures for a number of countries); and second, the financial assets of general
government are not easy to sell and some (such as contingent liabilities) can even transform into debt in times of deep
economic crisis (Paunovic, 2005; Lequiller and Blades, 2006).
ϱ
Given that the main focus of the paper is the quantitative assessment of the impacts of expenditure and revenue
composition on employment creation (Section 4) and that information for such analysis only exists for advanced
countries, the present paper has been focuses solely on such economies. The sample is comprised of 45 advanced
economies. Income groups are based on gross national income (GNI) per capita, according to the World Bank country
classification. “Advanced economies” refers to high-income countries, i.e. countries with a GNI per capita of US$ 12,276
3
Indeed, between 2007 and 2009 (when deficits reached their peak) fiscal deficits worsened in over 93
per cent of the countries analysed, increasing by 8.1 percentage points to reach an average deficit of
8.7 per cent of GDP in 2009. Meanwhile, public debt as a percentage of GDP increased in over 88
per cent of the countries analysed and increased further in 2010 in over 73 per cent of the countries
analysed (Figure 1). On average, between 2007 and 2009 the debt ratio increased by almost 17.5
percentage points, reaching close to 90 per cent of GDP in 2009. Moreover, debt ratios increased
further in 2011 – by 4.4 percentage points in one year – despite a contraction of fiscal deficits.
Figure 1. Public debt and fiscal balance as a percentage of GDP between 2007, 2009 and 2011
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&ŝƐĐĂůďĂůĂŶĐĞ
ϭϭϬ
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(-8.1)
Ͳϲ
(17.5)
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2007
2009
Ͳϵ
2011
2007
2009
2011
Note: Figures in parentheses show changes between 2007 and 2009. For the case of fiscal balances, a negative change
means a worsening in fiscal positions; that is, an increase in deficits.
The sample analysed is comprised of 45 advanced economies. Country group averages correspond to weighted
averages based on 2010 Purchasing Power Parity (PPP) GDP weights.
Source: Authors’ calculations based on IMF (2012a).
Importantly, the worsening of fiscal positions has less to do with the specific measures put in place to
address the impacts of the crisis and more with its indirect effects arising from revenue losses and
increases in expenditures – that is, reduced taxation, increased unemployment, etc.ϲ In the group of
advanced economies analysed, for example, the increase in fiscal expenditure as a percentage of
GDP – 4.6 percentage points between 2007 and 2010 – was the main destabilizing factor. This was
due to existing automatic stabilizers already in place rather than a discretionary effect. Yet, fiscal
revenues as a percentage of GDP also deteriorated, falling by 1.9 percentage points during this
period. In light of this, a number of countries have started to put measures in place to try to
consolidate their public finances.
or more. For an analysis of debt and deficit dynamics for emerging and developing countries, see Chapter 3 of World of
Work Report 2012 (ILO, 2012).
6
The deterioration of fiscal positions mainly reflected bailouts of the financial system, general spending increases and
losses in tax revenues (ILO, 2010).
4
Indeed, since public deficits attained their peak in 2009, countries’ consolidation programmes have
been reinforced and expanded. On the expenditure side – where government efforts have been
centred so far – fiscal spending as a percentage of GDP decreased by 1.4 percentage points between
the third quarters of 2009 and 2011. The more important factor contributing to this decrease was
compensation of employees. Despite the fact that spending in compensation of employees increased
in value – by 2 per cent between the third quarters of 2009 and 2011 – it increased less than what
economic growth would have allowed and as such contributed to over 36 per cent of the decline in
government expenditure. The same situation arose with respect to social spendingϳ that contributed
with 22.4 per cent to the decrease in government expenditure. Paradoxically, in some of the countries
where spending on social benefits as a percentage of GDP decreased – Hungary, Italy, Luxembourg,
Poland, Portugal, Slovakia and Spain – the number of unemployed individuals continued to rise – by
1.4 million in the third quarter of 2011 – compared to the same quarter in 2009. Another important
factor in the reduction of government expenditure was productive investment, which not only
decreased as a percentage of GDP but fell in value by 6 per cent during the same period. As such, it
contributed with 29.2 per cent of the decrease in total expenditure. On the income side, the share of
revenues in GDP increased by 1.2 percentage points in the two years to Q3 2011. This increase
happened mainly thanks to an increase in taxes received and at the expense of a reduction in social
contributions receivable. More specifically, the increase in taxes on income and wealth contributed
with close to 77 per cent of the increase in government revenues and the increase in taxes on
production and imports with close to 42 per cent of the increase.ϴ
Despite the vigour of fiscal consolidation measures, fiscal balances have not experienced a clear
improvement. In fact, with two exceptions – Portugal and Greeceϵ – deficit reductions have been on
the order of 2.6 percentage points. This leaves the median fiscal deficit in the group at the end of
2011 at around 6 per cent of GDP, with a number of countries (Greece, Ireland, Japan, United
Kingdom, and the United States) still bearing deficits around or above 10 per cent of GDP.
Moreover, in one-fourth of the countries analysed, the efforts to consolidate have failed to stabilize
public debt – e.g. Greece will only attain a debt-stabilizing primary balanceϭϬ in 10 years and Japan
in 12 years.
Importantly, the deterioration of macroeconomic and financial conditions of countries during the
financial crisis has not yet resulted in an increase in the cost of debt. In fact, in the four years leading
up to 2010, the ratio of interest payments on public debt – i.e. the cost of debt – has fallen in all
advanced countries but Norway and the Republic of Korea (that experienced a marginal increase in
the cost of debt). In terms of the share of interests in total government expenditure, the ratio also
7
Social spending includes social benefits plus social transfers in kind made through market producers, as defined by the
System of National Accounts (European Commission et al., 2009).
8
See Chapter 3 of World of Work Report 2012 (ILO, 2012) for a more detailed analysis on the factors contributing to the
reduction of expenditures and growth of revenues in advanced economies.
9
In Portugal, fiscal balance as percentage of GDP improved from a 10.2 per cent deficit in 2009 to a deficit equalling 4
per cent in 2011. In Greece, on the other hand, the fiscal deficit as percentage of GDP decreased by 6.4 percentage points
to 9.2 per cent in 2011.
10
Debt-stabilization primary balances (sp) are calculated following: ‫݌ݏ‬௧ ൌ ݀௧ିଵ ‫ כ‬
5
௥ି௡
௡ାଵ
(Martner and Tromben, 2004).
followed a steady decline (Figure 2). Between 2007 and 2010, 61 per cent of the advanced countries
analysed experienced a decline in the ratio of interests to government expenditure; and 67 per cent of
the countries saw these ratios decline even during 2010. In fact, the average increase in the ratio
between 2009 and 2010 comes mainly from a notable increase in public debt interests paid in the
United Kingdom and from spending cuts in Greece and the United States. These trends confirm that
the increase in public debt is not necessarily accompanied by a raise in interest rates. (Evans and
Marshall, 2001; Ardagna et al., 2007). However, the key question remains on how long this stability
will last.
Figure 2. Evolution of the ratio of interests on public debt over government expenditures, by
country group (percentages)
ϵ
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ϴ
ϳ
ϲ
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ϱ
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Note: The sample analysed is comprised of 45 advanced economies and 49 emerging economies.
Country group averages correspond to weighted averages based on 2010 Purchasing Power Parity (PPP) GDP
weights.
Source: Authors’ calculations based on OECD and UN National Accounts databases, national sources and IMF
(2011a).
More specifically, the relative stability of interest payments in advanced economies during the crisis
is not surprising given that most of their outstanding debt was issued on a medium- and long-term
basis. In the European Union, for example, between 60 and 94 per cent of treasury bonds (main
means through which public debt was financed during the crisis11) were classified as having a
11
The evolution of financial liabilities by country group reveals that the increase in public debt has been principally
financed by an increase in the issuance of treasury bonds. Indeed, in terms of the weights of the different debt
instruments in total debt, ‘securities, other than shares’ – which notably include the securities issued by the public
treasury to finance the public deficit – accounted, in high-income countries, for the bulk of the growth in public debt, i.e.
81.5 per cent, between 2007 and 2010. Already in 2007, treasury bonds accounted for more than three quarters of public
debt in these countries. During the crisis, the deterioration of fiscal positions produced a substantial issuance in treasury
bonds to finance the deficits, which brought the share of ‘securities, other than shares’ to 81.3 per cent of total public
debt (ILO, 2012).
6
maturity of more than five years.ϭϮ As such, the recent hikes in sovereign bond yields that followed
the euro crisisϭϯ will be detrimental if or when countries need to refinance their debts quickly at
higher interest rates. In this case, the cost of public debt could indeed have an influence on its
sustainability.ϭϰ In fact, there is already some indication – at least in a number of instances – of an
increase in the burden of public debt. The most important recent development is the sizable increase
in the spread between the real interest rate on public debt and the growth rate of real GDP – a key
parameter in assessing the sustainability of public debt.ϭϱ Indeed, during the crisis, the collapse of
output growth and the increase in interest rates brought the differential up to 7.2 percentage points in
2009 (Figure 3). The situation was somewhat reversed in 2010, but probably only temporarily given
that GDP growth turned negative in a number of advanced economies in 2011 and early 2012.
Although it is not possible to disregard the potential implications of the cost of debt, it should be
noted that other factors might be even more significant in the medium- to long- term to keep debt in
a sustainable track that allows for economic growth – such as productive investment,16 either
physical, human or social. This is all the more important in countries that have high levels of public
indebtedness but that are facing historically low interest rates – such as the United Kingdom, United
States and Japan. In fact, if these countries borrow to invest in productive activity, the new
borrowing could be self-financing given the low cost of debt.17
12
With the exception of Luxembourg where 91 per cent of the debt was issued with a maturity of 1 to 5 years (Eurostat
database) and Hungary, Cyprus and Romania where the average maturity of public bonds is less than 4 years (Economic
Intelligence Unit).
13
Between 2009 and 2010, 10-year government bond yields increased by 1.2 percentage points in the EU-15. Moreover,
investors will continue demanding higher compensations for the risk of holding debt they consider unsustainable. Alesina
et al. (1992) illustrates that for each percentage point increase in public debt as a percentage of GDP, risk premium
increases 1.6 basis points. Indeed, given the strains of the euro area sovereign debt crisis, estimates of the EIU
(Economist Intelligence Unit) for 2012 show that a number of countries will attain government bond yields above the socalled danger threshold of 7 per cent. This is the case of Italy and Spain (6 per cent), Ireland (8 per cent), Portugal (14.7
per cent), and Greece (16.5 per cent).
14
It is important to note that the pressure for fiscal consolidation in Eurozone countries suffering from the sovereign debt
crisis has an additional justification. In these countries, the risk of sovereign debt default is higher, given that: (i)
countries do not control the money supply of their domestic currency, and (ii) the European central bank is not their
lender of last resort (this is the reason why the risk premium in the United Kingdom is much lower than that of euro area
countries facing the sovereign debt crisis). As such, debt functions as a foreign-currency denominated liability in terms of
its risk assessment.
15
When this differential is positive – the interest rate is greater than the GDP growth rate – it means the public debt ratio
will not be sustainable in the absence of a sufficiently large primary surplus (Cecchetti et al., 2010).
16
See Aschauer (2000); Checherita and Rother (2010); Modigliani (1961).
17
Importantly, the fiscally-neutral expansion of public investment discussed later in the paper, would be less important in
these countries.
7
Figure 3. Evolution of the real public borrowing interest rates* and real GDP growth rates (percentages)
ϲ
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ƌĂƚĞ
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Ͳϰ
* This is the effective real interest rate on public debt and was calculated from government gross interest payments at
period (t) divided by government gross debt at period (t-1) minus the inflation rate (Cecchetti et al., 2010).
Source: Authors’ calculations based on OECD and UN National Accounts databases, national sources and IMF (2011a).
In addition, the strong and extremely fast pace of consolidation has been detrimental for the recovery
of labour markets. As seen above, countries have reinforced austerity through spending cuts that
affect employment either directly (e.g. cuts to public investment) or indirectly through the downward
spiral of a decrease in income levels of employees (e.g. cuts in public wages) and unemployed
individuals (e.g. social benefits). This has dampened consumption, thus depressing economic growth
and therefore delaying the hiring of workers. Indeed, as Figure 4 shows, fiscal consolidation has not
been associated with improvements in the labour market as expected by those who believed fiscal
austerity was the solution – especially when fiscal consolidation was implemented through cuts in
public spending (Figure 4, panel A). Moreover, in a number of instances fiscal consolidation has
been associated with a deterioration of the labour market situation (Figure 4, panel B). More
specifically, 96 per cent of the advanced economies that have been putting fiscal austerity measures
in place since 2009 – either through the increase in public revenues or the cut in public expenditures
– had in the third quarter of 2011 unemployment rates above pre-crisis ones. What is more, close to
54 per cent of those countries that have been consolidating have experienced a deterioration of
unemployment rates since the consolidation measures were first put in place in 2009 – i.e.
unemployment rates in 2011 were above the levels attained in 2009.
8
Figure 4. Fiscal austerity and labour market developments
Ϯ
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ŚĂŶŐĞŝŶƚŽƚĂůĞdžƉĞŶĚŝƚƵƌĞ;й'WͿ
Panel A: Fiscal austerity associated with a lack of labour market recovery
Ϭ
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ŚĂŶŐĞŝŶƚŽƚĂůĞdžƉĞŶĚŝƚƵƌĞ;й'WͿ
Panel B: Fiscal austerity associated with a deterioration of unemployment rates
Ϭ
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ŚĂŶŐĞŝŶƵŶĞŵƉůŽLJŵĞŶƚƌĂƚĞƐ͕ϮϬϬϵͲϭϭ
Source: Authors’ calculations based on ILO Laborsta, OECD and UN National Accounts databases, national sources and IMF
(2011a).
Despite all this, in 2012 austerity measures continued in most advanced countries, mainly through
expenditure cuts relative to GDP. Among the selected group of countries analysed,18 United
Kingdom, Portugal and Ireland showed the biggest cuts in public spending – by 2.8, 2.3 and 1.8
percentages points, respectively. In the United Kingdom and Ireland, productive investment bore the
brunt of cuts – falling by 2 and 1.2 percentage points, respectively – whereas in Portugal,
compensation of public sector employees was the focus of planned cutbacks – falling by 1.6
percentage points. In France, Spain, the United States and Japan, government expenditure reductions
were the result of cuts in social benefits. Only Denmark and Finland planned to increase total
expenditures in 2012. Greece also showed an increase in total expenditure, but it was a result of an
increase in interest payments on public debt. Meanwhile, Germany has been consolidating but at a
slow pace. On the income side, seven of the 18 countries analysed planned an increase in revenues
18
This sample is comprised of 18 countries for which information on 2012 government budgets exists.
9
for 2012 and in all of these countries – with the exception of Portugal – the increase was to come
from increased taxation, especially from personal income and corporate taxes. For example, in the
United States and Australia current taxes on income and wealth as percentage of GDP were planned
to rise by 1.7 and 1.4 percentage points, respectively. In Portugal, on the other hand, it was the rise in
indirect taxation that would drive the increase in public revenues.
There is also considerable variation in the intensity with which countries planned to implement this
consolidation process. For instance, in some countries such as Australia and France, the austerity
measures planned for 2012 were profound. In only one year (between 2011 and 2012) these countries
planned to achieve 77 and 68 per cent of the total improvement in primary fiscal balances necessary
to stabilize debt at 2007 levels. At this speed of consolidation, these countries would attain primary
balances that allow for debt stabilization over a very short period, i.e. 18 months. In Portugal, the
published plan for 2012 meant that debt stabilization would be attained over the next 3 years.
Meanwhile, in one-fourth of the countries analysed, despite the great extent of austerity measures,
primary fiscal balances that allow for public debt stability, will not be attained in the medium term –
e.g. Greece and Japan. Finally, there are countries that having enough fiscal space chose the austerity
path. Indeed, Norway planned to have a close to 13 per cent primary surplus although a 1 per cent
one was sufficient. The same occurs in Sweden and Switzerland. Together, these countries saved or
cut over US$ 1 trillion that could have been allocated to foster aggregate demand further.
Prolonging fiscal consolidation measures will be detrimental for fiscal balances and the debt ratio in
the medium-term, as it has been shown in this section, due mainly to a decrease in productivity and
the consequent fall in private investment (Ball and Mankiw, 1995; Heylen and Everaert, 2000).
Moreover, this approach will have devastating consequences for employment creation, as it will be
shown in the following section.
ͶǤ …‘‘‡–”‹…ˆ‹†‹‰•ǣ‡…‘…‹Ž‹‰ˆ‹•…ƒŽƒ†‡’Ž‘›‡–‰‘ƒŽ•
As seen in the previous section, since 2010 there has been an increased tendency among advanced
economies to focus on austerity measures – mainly centred on continued reductions in social
spending, downward pressure on wages, declines in public investment as well as raising direct
taxation – with views to quickly stabilizing fiscal balances. The measures have to a large extent been
counterproductive, not only in terms of fiscal stability but also in terms of employment objectives. In
particular, the labour market recovery in the majority of countries remains sluggish. In over 95 per
cent of the countries that have implemented austerity measures, unemployment rates are still above
their 2007 levels; and in over half of them the unemployment rate had still increased at the end of
2011.
Bringing fiscal balances back on a sustainable track such that governments can start putting in place
the necessary structural reforms is of utmost importance. The challenge, however, is to find the right
mix of measures that allow for medium-term deficit reduction without endangering the incipient
economic and labour market recovery. With this in mind, this section assesses quantitatively the
impacts of expenditure and revenue composition on employment creation to shed light on how fiscal
and employment goals can be achieved together.
10
ͶǤͳ
’‹”‹…ƒŽ•–”ƒ–‡‰›
The analysis consists of an econometric assessment based on a pooled cross-country and time-series
database for 32 advanced countries during the period 2007–2011 so as to assess the short-term
effects of fiscal variables on employment during the crisis. In order to explore the relationship
between the composition of fiscal balances and employment creation, the paper uses quarterly
information on expenditure and revenue items from Public Sector National Accounts.
The analysis is based on the fundamental Keynesian principle that fiscal balances can alter the
aggregate level of employment in the short term.19 With the aim of assessing the impact of fiscal
balance variables on employment, we estimate a semi-simultaneous equation model, consisting of
two different equations with real GDP and employment as dependent variables.
Based on the economic theory that describes the relationship between economic growth and fiscal
policy,20 the following model was estimated:
‫ܲܦܩ‬௜௧ ൌ ߙ଴ ൅ ߙଵ ‫ܲܦܩ‬௜௧ିଵ ൅ ߙଶ ‫݂݇݃݁ݐܽݒ݅ݎ݌‬௜௧ ൅ ߙଷ ‫݁݀ܽݎݐ‬௜௧ ൅ ߙସ ݈ܾܽ‫ݎݑ݋‬௜௧ ൅ ߙହ ‫ݕݎܽ݉݅ݎ݌‬௜௧ ൅
ߙ଺ ‫ݕݎܽ݀݊݋ܿ݁ݏ‬௜௧ ൅ ߙ଻ ‫ܮܣܥܵܫܨ‬௜௧ ൅ ߝ௜௧
(1)
Where:
GDP represents real gross domestic product; privategkf, private investment; trade, terms of trade;
labour, the labour force participation rate; primary, primary enrolment rate; secondary, secondary
enrolment rate; and FISCAL, a vector of independent fiscal variables. Table 1 contains the list of the
variables used for the regression analysis, as well as their definitions and sources of information.
The second equation of the model is a standard labour demand equation where employment is
derived from output level, labour costs and capital input:21
݁݉‫ݐ݊݁݉ݕ݋݈݌‬௜௧ ൌ ߚ଴ ൅ ߚଵ ‫ݏ݁݃ܽݓ‬௜௧ ൅ ߚଶ ݂݃݇௜௧ ൅ ߚଷ ‫ܲܦܩ‬௜௧ ൅ ݁௜௧
(2)
Where:
employment represents the total employed population; wages, compensation of employees of the
overall economy; gkf, gross capital formation of the overall economy; and GDP, real gross domestic
product.
With the aim of shedding light on the potential effect that fiscal variables have on employment, the
GDP parameter of equation (2) is substituted by equation (1). This results in a new equation (3),
which allows for an estimation of the relationships between fiscal balance composition variables and
19
See Blinder and Solow (1973); Pappa (2009); and Monacelli et al. (2010).
See Gupta et al. (2005).
21
See, for example, Layard and Nickell (1986).
20
11
employment:22
ሺ ݁݉‫ݐ݊݁݉ݕ݋݈݌‬௜௧ ൌ ߜ଴ ൅ ߜଵ ‫ܲܦܩ‬௜௧ିଵ ൅ ߜଶ ‫݂݇݃݁ݐܽݒ݅ݎ݌‬௜௧ ൅ߜଷ ‫݁݀ܽݎݐ‬௜௧ ൅ ߜସ ݈ܾܽ‫ݎݑ݋‬௜௧ ൅ ߜଷ ‫ܮܣܥܵܫܨ‬௜௧ ൅
(3)
‫ݒ‬௜௧
Based on this employment definition, two different specifications were estimated to assess, first, the
effects of changes in particular expenditure and revenue items on employment creation and, second,
the impact of changes in expenditure and revenue composition on employment creation.
The first specification was carried out to capture the effects that changes in particular spending and
revenue items would have on employment creation. Fiscal variables are therefore included in the
model as a percentage of GDP. The model is formulated as follows:
Žሺ݁݉‫ݐ݊݁݉ݕ݋݈݌‬ሻ௜௧ ൌ ߜ଴ ൅ ߜଵ ݈݊ሺ‫ܲܦܩ‬௜௧ିଵ ሻ ൅ ߜଶ ݈݊ሺ‫݂݇݃݁ݐܽݒ݅ݎ݌‬௜௧ ሻ ൅ ߜଷ ‫݁݀ܽݎݐ‬௜௧ ൅ ߜସ ݈ܾܽ‫ݎݑ݋‬௜௧ ൅
ߜହ ‫ܲܦܩ̴ݏ݁݃ܽݓܾݑ݌‬௜௧ ൅ ߜ଺ ‫ܲܦܩ̴ݏ݁݅݀݅ݏܾݑݏ‬௜௧ ൅ ߜ଻ ݅݊‫ܲܦܩ̴ݐݏ݁ݎ݁ݐ‬௜௧ ൅ ߜ଼ ܾ݂݁݊݁݅‫ܲܦܩ̴ݏݐ‬௜௧ ൅
ߜଽ ‫ܲܦܩ̴݀݅ܽ݌݂ݏ݊ܽݎݐݎ݄݁ݐ݋‬௜௧ ൅ ߜଵ଴ ‫ܲܦܩ̴݂݈ܾ݇݃ܿ݅ݑ݌‬௜௧ ൅ ߜଵଵ ݅݊݀‫ܲܦܩ̴ݏ݁ݔܽݐ‬௜௧ ൅
ߜଵଶ ‫ܲܦܩ̴݁݉݋ܿ݊݅ݕݐݎ݁݌݋ݎ݌‬௜௧ ൅ ߜଵଷ ݅݊ܿ‫ܲܦܩ̴ݏ݁ݔܽݐ݁݉݋‬௜௧ ൅ ߜଵସ ܿ‫ܲܦܩ̴ݐݑܾ݅ݎݐ݊݋‬௜௧ ൅
(4)
ߜଵହ ‫ܲܦܩ̴ܿ݁ݎ݂ݏ݊ܽݎݐݎ݄݁ݐ݋‬௜௧ ൅ ߜଵ଺ ݇‫ܲܦܩ̴ܿ݁ݎ݂ݏ݊ܽݎݐ‬௜௧ ൅ ‫ݒ‬௜௧
Where:
pubwages_GDP represents public expenditure on wages and salaries; subsidies_GDP, subsides
payable; interest_GDP, interest payments on public debt; benefits_GDP, public expenditure on
social benefits; othertransfpaid_GDP, other current transfers paid; publicgkf_GDP, public
investment; indtaxes_GDP, indirect taxes received; propertyincome_GDP, property income
received; incometaxes_GDP, income taxes received; contribut_GDP, social contributions;
othertransfrec_GDP, other current transfers received; and ktransfrec_GDP, capital transfers
received.
Mindful of the challenge that countries face in achieving the stability of fiscal balances without
damaging an incipient economic recovery and hurting the labour market further, a second
specification of the employment model was carried out. In this second model we measure fiscal
variables in relation to total expenditures or total revenues in order to assess the impact of changes in
the composition of expenditure and revenues on employment creation. The model is formulated as
follows:
݈݊ሺ݁݉‫ݐ݊݁݉ݕ݋݈݌‬ሻ௜௧ ൌ ߜ଴ ൅ ߜଵ ݈݊ሺ‫ܲܦܩ‬௜௧ିଵ ሻ ൅ ߜଶ ݈݊ሺ‫݂݇݃݁ݐܽݒ݅ݎ݌‬௜௧ ሻ ൅ ߜଷ ‫݁݀ܽݎݐ‬௜௧ ൅ ߜସ ݈ܾܽ‫ݎݑ݋‬௜௧ ൅
ߜହ ݂݅‫ܲܦܩ̴݈ܽܿݏ‬௜௧ ൅ ߜ଺ ‫݌ݔ̴݁ݏ݁݃ܽݓܾݑ݌‬௜௧ ൅ ߜ଻ ‫݌ݔ̴݁ݏ݁݅݀݅ݏܾݑݏ‬௜௧ ൅
ߜ଼ ݅݊‫݌ݔ̴݁ݐݏ݁ݎ݁ݐ‬௜௧ ൅ ߜଽ ܾ݂݁݊݁݅‫݌ݔ̴݁ݏݐ‬௜௧ ൅ ߜଵ଴ ‫݌ݔ̴݁݀݅ܽ݌݂ݏ݊ܽݎݐݎ݄݁ݐ݋‬௜௧ ൅ ߜଵଵ ‫݌ݔ̴݂݈ܾ݁݇݃ܿ݅ݑ݌‬௜௧ ൅
ߜଵଶ ݅݊݀‫ݒ݁ݎ̴ݏ݁ݔܽݐ‬௜௧ ൅ ߜଵଷ ‫ݒ݁ݎ̴݁݉݋ܿ݊݅ݕݐݎ݁݌݋ݎ݌‬௜௧ ൅ ߜଵସ ݅݊ܿ‫ݒ݁ݎ̴ݏ݁ݔܽݐ݁݉݋‬௜௧ ൅
(5)
ߜଵହ ܿ‫ݒ݁ݎ̴ݐݑܾ݅ݎݐ݊݋‬௜௧ ൅ ߜଵ଺ ‫ݒ݁ݎ̴ܿ݁ݎ݂ݏ݊ܽݎݐݎ݄݁ݐ݋‬௜௧ ൅ ߜଵ଻ ݇‫ݒ݁ݎ̴ܿ݁ݎ݂ݏ݊ܽݎݐ‬௜௧ ൅ ‫ݒ‬௜௧
22
This extended employment equation does not include some of the variables included in the economic growth and
labour models described in equation (1). Primary and secondary enrolment rates and compensation of employees of the
overall economy were excluded from equation (3) because there are no quarterly data available for all countries in our
sample.
12
Where:
fiscal represents the fiscal balance of the general government (as a percentage of GDP);
pubwages_exp, public expenditure on wages and salaries; subsidies_exp, subsides payable;
interest_exp, interest payments on public debt; benefits_exp, public expenditure on social benefits
and social transfers in kind; othertransfpaid_exp, other current transfers paid; and publicgkf_exp,
public investment (all these variables are measured as a percentage of total expenditure). Moreover,
indtaxes_rev represents indirect taxes received; propertyincome_rev, property income received;
incometaxes_rev, income taxes received; and contribut_rev, social contributions; othertransfrec_rev,
other current transfers received; and ktransfrec_rev, capital transfers received (all these variables as a
percentage of total revenues).
Each model was estimated first using pooled ordinary least squares (OLS) and country fixed effects
given the results of the Hausman test in favour of this specification. Indeed, unobserved countryspecific effects is a common problem encountered when working with panel data. In such case,
excluding unobserved country-specific effects could lead to serious biases in the coefficient
estimated, particularly when these effects are correlated with the other covariates.23 Moreover, the
model was estimated with controls for unobservable time-specific effects in order to remove timerelated shocks from the errors and prevent “contemporaneous correlation”, which is the most likely
form of cross-individual correlation. The model was also tested for multicollinearity, following the
VIF regress command, and for heteroskedasticity using the robust option available. The models
failed to pass these tests.
Moreover, serial correlation was verified through the Lagram-Multiplier test (Wooldridge, 2002;
Drukker, 2003) and the abar post-estimation technique (Roodman, 2006). In all cases, the null
hypothesis was rejected, concluding that the data suffered from first order autocorrelation. Under this
circumstance, OLS and fixed-effects models are biased and inconsistent, respectively, since they
underestimate standard errors of the coefficients. An additional estimator was therefore used in both
specifications: a feasible generalized least squares model (GLS) fitted for panel-data. This estimator
allows for the assessment in the presence of AR(1) autocorrelation within panels, cross-sectional
correlation and heteroskedasticity across panels.
It is important to note that when dealing with fiscal policy variables, a common issue is the likely
presence of endogeneity or reverse causality, i.e. some fiscal policies may have an impact on
employment, but employment may also be affecting some fiscal items. Under this circumstance, it
has been widely demonstrated that coefficients estimated through fixed effects might be inconsistent
and biased, since they are based on the assumption of strict exogeneity. To address this potential
problem of endogeneity, we have carried outan instrumental variables approach through a 2 states
least squares (2SLS) estimator (see section 4.4 for more details). Results of the pooled ordinary least
squares model (OLS), GLS (fixed-effects), FGLS with AR1 correction, and IV estimates are
presented in Tables 1 and 2 below.
23
Gupta et al. (2005).
13
Table 1. Definitions and sources of variables used in the regression analysis
ͶǤʹ
Variable
Definition
Employment
Employed persons aged 15-64
Real GDP
Gross domestic product in real terms
Private investment
Private sector gross capital formation
Trade
Terms of trade
Labour
Labour force participation rate: 15-64 years old
Fiscal balance
Fiscal balance of General Government
Public wages and salaries
Compensation of employees of General
Government
Subsidies
Subsidies, payable
Interest payments
Interest payments on public debt
Social benefits
Social benefits and social transfers in kind (via
market producers), payable
Other current transfers
paid
Other current transfers, payable
Public investment
Gross capital formation of General Government
Indirect taxes
Taxes on production and imports, receivable
Property income
received
Property income, receivable
Income taxes
Current taxes on income, wealth etc., receivable
Social contributions
Social contributions, receivable
Other current transfers
received
Other current transfers, receivable
Capital transfers received
Capital transfers, receivable
Source
OECD. Stat; Eurostat and
National sources
OECD. Stat; Eurostat and
National sources
OECD. Stat; Eurostat and
National sources
OECD. Stat; Eurostat and
National sources
OECD. Stat; Eurostat and
National sources
OECD. Stat; Eurostat and
National sources
OECD. Stat; Eurostat and
National sources
OECD. Stat; Eurostat and
National sources
OECD. Stat; Eurostat and
National sources
OECD. Stat; Eurostat and
National sources
OECD. Stat; Eurostat and
National sources
OECD. Stat; Eurostat and
National sources
OECD. Stat; Eurostat and
National sources
OECD. Stat; Eurostat and
National sources
OECD. Stat; Eurostat and
National sources
OECD. Stat; Eurostat and
National sources
OECD. Stat; Eurostat and
National sources
OECD. Stat; Eurostat and
National sources
•–‹ƒ–‹‘”‡•—Ž–•
Results of the first estimation, looking at the impact of particular fiscal balance components on
employment are presented in Table 2. In particular, column 3 reports the results estimated by FGLS
with AR1 correction, which is our preferred specification. These findings show that in the short term
and during times of crisis, public spending on social benefits and investment has a strong positive
relationship with employment. A 1 percentage point increase in each of these expenditures (as a
percentage of GDP) is associated, respectively, with a 0.04 and 0.02 per cent increase in
employment. These results confirm the analysis presented above, which shows that in countries
where spending on social benefits as a percentage of GDP decreased the most, the number of
14
unemployed individuals continued to rise during the period analysed. This is in line with other
studies’ findings showing the important role of social benefits as economic demand stabilizer.24
Likewise, public investment has the potential to stimulate growth and crowd-in private investment,
especially in those sectors where there is an initial need for basic infrastructure.25 In line with this,
our results show that after controlling for movements in the cycle and other fiscal variables, the net
effect of social benefits and public investment on employment remains positive.
On the other hand, increasing public spending on subsidies and the interests of debt would have
detrimental effects on employment. A one percentage point increase in these two types of spending
would have an employment reducing effect of 0.08 and 0.04 per cent, respectively. Public
expenditure in wages and salaries is also negatively correlated with employment, albeit at the 10 per
cent level. An increase of one percentage point in public wages would be associated with a 0.01 per
cent decrease in employment. These findings suggest that reducing public wages and salaries would
not be as detrimental for employment as a fiscal consolidation approach centred in public
investment’s and social benefits’ cuts. In turn, this suggests that from an employment perspective a
distribution of the social costs of reforms would not be detrimental, hypothetically. In other words,
public officials could carry part of the weight of reforms while income support measures (carried out
through an increase in social benefits) are extended to a greater number of individuals in vulnerable
situations. However, this type of approach would possible depend on the size of such redistribution.
It may arrive a point, where a decrease in public wages would start having negative consequences on
employment. Moreover, this result does not take into account the social and psychosocial effects of
this type of measure on the affected group, which may have detrimental spill over effects on the
society as a whole.
On the revenue side, other current transfers26 revealed a positive and highly significant relationship
with employment – a 1 percentage point increase in this revenue would be associated with a 0.09 per
cent increase in employment. Meanwhile, indirect taxes and capital transfers received show a
significantly negative effect on employment. A one percentage point increase in these two types of
revenues would be associated with a 0.05 and 0.01 per cent decrease in employment, respectively.
These findings are line with existing literature. Indeed, indirect taxes are in general regressive; hence
an increase in this type of taxation is generally associated with negative effects on aggregate demand
and job creation. As such, an increase in indirect taxes may need to be accompanied by measures
aimed to support the disposable income of poorer households in order to make measures more
redistributive.27
24
ILO, 2013.
25
Ibid.
26
Other current transfers include four categories, notably “insurance-related transactions, transfers within government,
current international cooperation and miscellaneous current transfers.” (European Commission et al., 2009).
27
For a more extensive discussion on this, please refer to Chapter 5 of the World of Work Report 2011 (ILO, 2011).
15
Table 2. Regression results of the first specification
Ln of employment
Lag of ln of Real GDP
Ln of private investment
Terms of trade
Labour force participation rate
Public wages and salaries (% of GDP)
Subsidies (% of GDP)
Interest payments (% of GDP)
Social benefits (% of GDP)
Other current transfers paid (% of GDP)
Public investment (% of GDP)
Indirect taxes (% of GDP)
Property income received (% of GDP)
Income taxes (% of GDP)
Social contributions (% of GDP)
Other current transfers received (% of GDP)
Capital transfers received (% of GDP)
Constant
Observations
R-squared
Number of countries
(1)
(2)
(3)
(4)
0.0111
(0.0829)
0.448***
(0.0806)
-0.0281***
(0.0031)
-0.0022
(0.0065)
-0.0602***
(0.0081)
-0.247***
(0.0491)
-0.0933***
(0.0258)
0.118***
(0.0127)
-0.124***
(0.033)
0.0209
(0.0142)
-0.0623***
(0.0114)
0.0141
(0.0194)
0.0215***
(0.0077)
-0.0179
(0.0135)
0.111***
(0.024)
-0.0449***
(0.0173)
6.646***
(0.532)
555
0.752
0.0815***
(0.0161)
0.0117***
(0.0036)
-0.0013***
(0.0001)
0.0175***
(0.001)
0.0004
(0.0004)
0.0037**
(0.0018)
-0.0026**
(0.0011)
-0.0002
(0.0005)
0.0002
(0.0011)
0.0003
(0.0004)
-0.0024***
(0.0007)
-0.0013
(0.0009)
0.0006*
(0.0003)
-0.0007
(0.0009)
-0.0017
(0.0013)
-0.0007
(0.0005)
6.123***
(0.2)
555
0.681
32
0.283***
(0.0497)
0.169***
(0.0488)
-0.0146***
(0.0024)
-0.0162**
(0.0067)
-0.0084*
(0.0050)
-0.0789***
(0.0295)
-0.0355**
(0.0163)
0.0382***
(0.0091)
-0.0199
(0.016)
0.0182***
(0.0065)
-0.0479***
(0.0079)
0.0054
(0.012)
-0.002
(0.0048)
0.0089
(0.0101)
0.0908***
(0.0159)
-0.0134*
(0.0074)
6.081***
(0.539)
555
-0.0458
(0.0820)
0.505***
(0.0724)
-0.0327***
(0.00416)
0.00601
(0.00775)
-0.0721***
(0.0102)
-0.229***
(0.0667)
-0.0862***
(0.0286)
0.164***
(0.0192)
-0.137***
(0.0375)
0.0442**
(0.0195)
-0.0796***
(0.0128)
0.0401**
(0.0191)
0.0132
(0.0123)
-0.0518***
(0.0172)
0.0804***
(0.0247)
-0.0454***
(0.0158)
6.537***
(0.589)
491
0.751
32
Notes: Standard errors in parentheses. Significance levels: * at 10 per cent; ** at 5 per cent; *** at 1 per cent. (1) Pooled
ordinary least squares model (OLS); (2) GLS (fixed-effects); (3) FGLS with AR1 correction; and (4) IV estimates. Fixed
effects and FGLS estimates include year dummies. IV estimates have been run by 2SLS, using gmm and robust options
to compute efficient estimates in presence of heteroskedasticity and autocorrelation.
The findings of the second estimation, which examines the impact of changes in expenditure and
16
revenue composition on employment, are detailed in Table 3. Results presented in column 3 (our
preferred specification) show that a 1 percentage point increase in social benefits (as a percentage of
total expenditure) would be associated with a 0.02 per cent increase in employment. Meanwhile, a
redistribution of public expenditure towards subsidies paid, interests on debt and public wages would
have detrimental effects on employment. More specifically, a 1 percentage point increase in the ratio
of subsidies paid, interest payments and public wages to total expenditure would be associated with a
0.09, 0.02 and 0.01 per cent employment reduction, respectively.
In terms of the revenue composition, the ratios of other current transfers received and social
contributions to total public income have a positive and significant relationship with employment in
the short term. Raising these rations by 1 percentage point would have an employment-increasing
effect of 0.08 and 0.04 per cent, respectively. Likewise, the ratios of income taxes and property
income received show employment-enhancing effects totalling 0.02 per cent for a one percentage
point increase in each of these ratios. In a nutshell, results from our second specification indicate that
the composition of fiscal consolidation matters. More specifically, countries where spending is
concentrated on social benefits and other transfers and were revenues are centred in direct taxation
(such as social contributions and income taxes) would tend to have higher employment creation.
Table 3. Regression results of the second specification
Lag of ln of Real GDP
Ln of private investment
Terms of trade
Labour force participation rate
Fiscal balance (% of GDP)
Public wages and salaries (% of total expenditure)
Subsidies (% of total expenditure)
Interest payments (% of total expenditure)
Social benefits (% of total expenditure)
Other current transfers paid (% of total
expenditure)
Public investment (% of total expenditure)
Indirect taxes (% of total revenues)
(1)
0.0873
(0.0671)
0.364***
(0.0673)
-0.0239***
(0.0033)
0.0014
(0.0066)
-0.0017
(0.0034)
-0.0343***
(0.008)
-0.262***
(0.0289)
-0.0664***
(0.0154)
0.0375***
(0.0077)
-0.0047
(0.0186)
-0.0179
(0.0128)
-0.0386*
(0.0197)
17
Ln of employment
(2)
(3)
0.0777***
0.391***
(0.0165)
(0.0453)
0.0172***
0.061
(0.0035)
(0.0462)
-0.0009*** -0.0148***
(0.0001)
(0.0024)
0.0121***
-0.0035
(0.001)
(0.0067)
0.0002
-0.0033
(0.0002)
(0.0025)
0.0011**
-0.0149**
(0.0005)
(0.006)
-0.0004
-0.0979***
(0.0014)
(0.0201)
-0.0018*** -0.0249***
(0.0006)
(0.009)
-0.0019*** 0.0204***
(0.0004)
(0.0054)
-0.0003
-0.0019
(0.0006)
(0.0088)
0.0015***
0.0064
(0.0004)
(0.0062)
0.005***
0.0112
(0.0009)
(0.0118)
(4)
0.0322
(0.0660)
0.421***
(0.0613)
-0.0268***
(0.0041)
0.00244
(0.0083)
-0.00425
(0.00346)
-0.0278***
(0.00958)
-0.255***
(0.0412)
-0.0582***
(0.0203)
0.0463***
(0.0119)
0.00597
(0.0236)
0.00179
(0.0195)
-0.0875*
(0.0512)
Property income received (% of total revenues)
Income taxes (% of total revenues)
Social contributions (% of total revenues)
Other current transfers received (% of total
revenues)
Capital transfers received (% of total revenues)
Constant
Observations
R-squared
Number of countries
-0.0083
(0.0201)
0.0187
(0.0172)
0.0203
(0.019)
0.0982***
(0.0195)
-0.0392*
(0.0214)
6.531***
(1.916)
555
0.782
0.0036***
(0.0010)
0.0058***
(0.0008)
0.005***
(0.001)
0.005***
(0.0011)
0.004***
(0.0009)
5.957***
(0.218)
555
0.694
32
0.0232*
(0.0120)
0.0233**
(0.0111)
0.0449***
(0.0128)
0.078***
(0.0137)
0.0198
(0.0123)
2.421*
(1.261)
555
-0.0326
(0.0444)
0.00470
(0.0424)
-0.00152
(0.0442)
0.0773**
(0.0378)
-0.0560
(0.0443)
8.728**
(4.386)
491
0.773
32
Notes: Standard errors in parentheses. Significance levels: *at 10 per cent; **at 5 per cent; ***at 1 per cent. (1) Pooled
ordinary least squares model (OLS); (2) GLS (fixed-effects); (3) FGLS with AR1 correction; and (4) IV estimates. Fixed
effects and FGLS estimates include year dummies. IV estimates have been run by 2SLS, using gmm and robust options
to compute efficient estimates in presence of heteroskedasticity and autocorrelation.
ͶǤ͵
–‡”’”‡–ƒ–‹‘‘ˆ”‡•—Ž–•
Several scenarios were calculated on the base of the above relationships to examine in more detail
the trade-offs of a change in the policy mix. Firstly, we calculated a baseline scenario to illustrate the
effect on employment of a continuation of the 2011 approach of fiscal consolidation during 2012 and
2013.28 This scenario shows that if countries had kept the same policy mix of 2011 during 2012,
employment in the group would have grown but only moderately – by 0.2 per cent, which is 0.9
additional million jobs between Q4 2012 and Q4 2013.
Then, we calculated four additional scenarios to illustrate the potential impact that a fiscally neutral
change in the composition of fiscal balances (i.e. a change in the policy mix, while keeping 2011
deficits constant) could have on employment creation (Figure 5). A number of interesting results
arise from the analysis:
•
An increase in expenditure in social benefits as a percentage of total expenditures – by 1
percentage point – financed by an increase in revenues derived from direct taxation,29 appears
to be the most effective policy-mix in terms of employment creation (Scenario 1). Indeed, 2
million jobs would have been created between Q4 2012 and Q4 2013 thanks to this policy
28
The 2011 consolidation efforts are characterized by a combination of a 1.98 per cent cut in the ratio of public wages to
GDP with a 7.82 per cent cut in the public investment ratio and an increase of 3.8 per cent in the income tax ratio to
GDP.
29
Direct taxes refer to “taxes on income and wealth” as defined in the National Accounts. They include taxes on income,
which consist on taxes on individual or household incomes, but also taxes on profits (income of corporations) and taxes
on capital gains. Direct taxes also include a number of taxes on capital, consisting mainly of taxes on the property or net
wealth of institutional units (excluding taxes on land) (Lequiller et al., 2006; European Commission et al., 2009).
18
mix, compared to only 0.9 million jobs if countries had continued to implement the 2011
austerity policies.
•
Alternatively, if this scenario were financed by a decrease in interests on public debt, 1.7
million jobs could have been created between Q4 2012 and Q4 2013 (Scenario 2). True, this
scenario is illusory since countries are not in a position to decide whether to reduce interest
payments from one year to the other. However, the interest of this scenario is to illustrate the
difference it would make in terms of employment creation if countries would enhance their
efforts to reduce public debt.
•
Moreover, an increase in social benefits and subsidies in an effort to raise aggregate demand
and production would have a positive effect on employment creation too, but markedly less
important than an increase in social benefits alone. Indeed, an increase of half a percentage
point in social benefits and another half a percentage point in subsidies,30 financed by an
increase in revenues derived from direct taxation, would be associated with 1 additional
million jobs in the four quarters to Q4 2013 (Scenario 3).
•
In this same scenario, if the increase in aggregate demand would be carried forward through a
raise in public wages rather than social benefits, there would be 0.5 million jobs created
between Q4 2012 and Q4 2013. This illustrates that using a redistributive source of public
revenue to compensate for regressive-type of spending would yield the least advantageous
policy-mix in terms of employment creation (Scenario 4).
30
Subsidies are “current unrequited payments that government units, including non-resident government units, make to
enterprises on the basis of the levels of their production activities or the quantities or values of the goods or services that
they produce, sell or import” (European Commission et al., 2009).
19
Figure 5. Simulations – number of jobs that could be created between Q4 2012 and Q4 2013 depending on different
policy mix scenarios*, advanced economies (millions of jobs)
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*All scenarios simulate changes in the composition of fiscal balances. They are based on the assumption that increases in
expenditures are either offset by reductions in other expenses or financed by increases in revenues. Expenditure items are
measured as a percentage of total expenditures and revenue items as a percentage of total revenues.
**The continued policy mix corresponds to austerity in the 2011 form. See footnote 30.
Source: Authors’ calculations based on OECD and national sources.
ͶǤͶ
‡•‹–‹˜‹–›ƒƒŽ›•‹•
This section discusses the robustness checks that have been carried out to evaluate the sensitivity of
the parameters presented in first three columns of tables 2 and 3 based on a number of postestimation techniques, tests and alternative specifications.
The use of different estimators – OLS, GLS (fixed effects) and FGLS (AR1) – in the two equations,
as discussed earlier in the section, can be considered as the first robustness check. Overall results
seem to hold, giving confidence to the empirical results. Along with this, a number of tests were
included in the different specifications. First, the dependent variables were controlled for nonstationarity through the augmented Dickey-Fuller test. In all cases the tests rejected the null
hypotheses of non-stationarity at 1 and 5 per cent levels. In addition, time effects have been included
when fitting the model in both specifications. The models were also tested for multicollinearity,
following the VIF regress command, and for heteroskedasticity using the robust option available,
which the models failed to pass.
The problem of heteroskedasticity along with that of serial correlation and endogeneity have been
taken especially seriously and have been dealt with through a number of tests and estimation
techniques. First of all, the Lagram-Multiplier test (Wooldridge, 2002; Drukker, 2003) and the abar
20
post-estimation technique (Roodman, 2006) were used to test for serial correlation in the
idiosyncratic error terms. Given that the results of these tests confirmed the presence of first order
autocorrelation, all specifications were run with a FGLS estimator, which allows the assessment in
the presence of AR(1) autocorrelation within panels, cross-sectional correlation and
heteroskedasticity across panels. However, as mentioned above, all previous specifications assume
that all of the fiscal variables included in both equations are exogenous to employment. Yet, a
commonly discussed issue in the literature of fiscal policy is the likely presence of endogeneity or
reverse causality (Gupta et al., 2005). In order to account for this potential problem, an instrumentalvariable approach was undertaken. More specifically, the two models were estimated instrumenting
for the endogenous variables, notably social benefits, indirect taxes, income taxes and social
contributions. We used as instruments the lagged values of these endogenous variables and all other
exogenous variables included in the model. All models were estimated using the gmm and robust
options to compute efficient estimates in presence of heteroskedasticity and serial correlation. All
instruments were found to be valid according the J statistic of the Hansen test for overidentifying
restrictions. In addition, the Anderson’s canonical correlations test confirmed that there are enough
adequate instruments to estimate the equations (Baum, 2006).
Column 4 of Tables 2 and 3 shows the results of the instrumental variables regressions for the first
and the second specification, respectively. When looking at the impact of particular fiscal balance
components on employment, the results broadly confirm the findings of previous estimations. After
instrumenting for the potentially endogenous fiscal variables, social benefits and indirect taxes
continue to have a positive and negative impact, respectively, on employment. Likewise, income
taxes remain statistically insignificant. However, a difference in the results is that, when
instrumenting for these endogenous variables, the coefficient of the variable social contributions in
GDP becomes negative and highly significant. This would suggest that an increase of one percentage
point in this variable would be associated with a 0.05 per cent decrease in employment. Thus,
reductions in social security contribution rates, especially for hiring more vulnerable workers, could
stimulate job creation.
Regarding the second specification, which examines the impact of changes in the expenditure and
revenue composition on employment, the IV estimates produce a number of different results. After
accounting for endogeneity, the ratio of indirect taxes to total public income becomes negative and
statistically significant. As mentioned above, these findings are in line with existing literature and
imply that an increase in indirect taxes is associated with negative effects on aggregate demand and
job creation. Another difference in results arising from instrumenting is that the coefficients of
income taxes and social contributions ratios become statistically insignificant. Finally, instrumenting
social benefits (as a percentage of total expenditure) does not change its effect; it continues having a
positive and significant impact on employment.
ͷǤ ‘…Ž—•‹‘•ƒ†’‘Ž‹…›‹’Ž‹…ƒ–‹‘•
In this paper, we have examined the relationship between budget deficit and the composition of fiscal
balance, and employment creation for a panel of 32 advanced economies during the 2007–2011
global crisis period. In line with previous studies in the literature which sustain that the composition
21
of fiscal consolidation matters, this paper has found that a fiscally-neutral change in the deficit
composition would be efficient in boosting job creation. Indeed, the analysis shows that, in the short
term and during times of crisis, a 1 percentage point increase in social benefits (as percentage of total
expenditures) would be associated with an increase in employment by 0.02. On the revenue side, a 1
percentage point increase in the ratio of other current transfers received, social contributions and
income taxes to total revenues would raise employment by 0.08, 0.04 and 0.02 per cent, respectively.
To put these coefficients in perspective, a fiscally neutral change in the composition of expenditures
and revenues would create between 0.5 and 2 million jobs in the following year alone, depending on
the selected policy mix. In this respect, an increase in expenditure in social benefits as a percentage
of total expenditures (by 1 percentage point) financed by an increase in direct taxation, appears to be
the most effective policy-mix in terms of employment creation. Moreover, this increase would not be
vain. In fact, 2 additional million jobs would account for 10.2 per cent of the total number of jobs
needed in Q3 2013 to restore employment rates to pre-crisis levels (Q3 2007). However, it is
important to note that this analysis does not take into consideration the important issue of the quality
of the jobs that are expected to be created.
Although not in the scope of this paper, it is important to note that choosing the correct expenditure
and revenue composition when putting in place austerity measures and consolidating public finances
at the right pace, crucial as it is, will not be enough. International policy coordination is also needed.
Section 3 of this paper showed that there is a great deal of variation in the policy mix and the
intensity of fiscal consolidation across countries, which highlights the absence of policy coordination among countries. Indeed, countries are trying to cut fiscal deficits fast in the expectation
that others would take the lead in boosting global growth. However, attention needs to be paid to
inward-looking policies in the face of a global crisis for they may adversely affect other countries
and the global recovery more broadly. Historical evidence from the Great Depression of the 1930s
and the deep recessions of the 1970s and 1980s,31 and more recent empirical evidence32 have
suggested that the potential gains of coordinated policy efforts are substantial. And the current crisis
has numerous examples33 that show that unilateral macroeconomic policies are costly (mainly in
terms of inflation and foreign borrowing), risky (e.g. often linked to beggar-thy-neighbour type
policy scenarios) and difficult to sustain.
31
Oudiz et al. (1984).
A number of theoretical and empirical analyses, based on a variety of approaches, have argued about the significant
gains from coordination. See for example: Canzoneri et al. (2005), Cooley and Quadrini (2002), Kollmann (2002), Pappa
(2002), Sutherland (2002) and Tchakarov (2002).
33
To cite two of them, inward-looking government bailouts to financial institutions, e.g. the one in the United States,
drew much needed capital from the rest of the world, especially from developing countries. Another example is the
implementation in early-October of a deposit guarantee in Ireland, which dragged an amazing number of depositors from
British banks, nearly inducing a run on deposits. See Frieden (2009).
32
22
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